Is the Bankruptcy Code an Adequate Mechanism for Resolving the Distress of Systemically Important Institutions?

Abstract

Lehman’s bankruptcy has triggered calls for new approaches to rescuing systemically important institutions. This essay assesses and confirms the need for a new approach. It identifies the inadequacies of the Bankruptcy Code and advocates an approach modeled on the current regime governing commercial banks. That regime includes both close monitoring when a bank is healthy and aggressive intervention when it is distressed. The two tasks—monitoring and intervention—are closely tied, ensuring that intervention occurs only when there is a well-established need for it. The same approach should be applied to all systemically important institutions. President Obama and the Congress are now considering such an approach, though it is unclear whether it will establish a sufficiently close connection between the power to intervene and the duty to monitor. The proposed legislation is unwise if it gives the government power to seize an institution regardless of whether it was previously subject to monitoring and other regulations.